China, the International Monetary Fund (IMF), and interested think tanks have been pushing the idea of private SDR since the beginning of the year. It has now come to fruition. But what does it actually mean?

Initially, SDR-denominated bonds will be of particular interest to official investors, but gradually, they will also attract investors from private sectors.

— Zhu Jun, director general, PBOC

The so-called SDR is an IMF construct of real currencies, right now the euro, yen, dollar, and pound, without actually containing any of them. It is just a claim to demand payment in these currencies. It made news last year when the Chinese renminbi was also admitted, although it won’t formally be part of the basket until Oct. 1 of this year. The IMF and member countries trade the units currently worth $1.40 among each other.

“Initially, SDR-denominated bonds will be of particular interest to official investors, but gradually, they will also attract investors from private sectors. In such a way an SDR bond market will be developed,” Zhu Jun, the director general of the People’s Bank of China’s (PBOC) international department told Chinese business paper Caixin.

Worth Wray, the chief global macro strategist of STA Wealth Management agrees: “Right now there is no organic demand, but over a five-year horizon it could develop globally and maybe that creates another channel for capital to flow into China—if that’s the only market there is for it,” he said in an interview.

The SDR bonds issued by the two official institutions are different from the official SDR issued by the IMF. In fact, they are a derivative of it. When the World Bank unit called International Bank for Reconstruction and Development (IBRD) issues the bonds, it receives payment in yuan from the Chinese market or at first from the issue’s underwriter, the Industrial and Commercial Bank of China.

Chinese investors receive the SDR bonds, but what do they actually own?

For the Chinese investors, there is the advantage that they can hold a sizeable non-yuan denominated asset in China and reduce their risk to the Chinese currency.

Official SDRs can be redeemed for dollars, euros, yen, pound, and soon yuan through the IMF. However, the new private SDR, or M-SDR as the IMF calls them, cannot. The new bonds represent a claim on the IBRD. Since the IBRD doesn’t have any SDR assets, the repayment will also be in yuan, dollar, euro, yen, or pounds. So what’s the point of having this new basket?

For the IBRD, there is no advantage because it is borrowing in strong currencies and getting paid in a relatively weak one. For the Chinese investors, there is the advantage that they can hold a sizeable non-yuan denominated asset in China and reduce their risk to the Chinese currency, which may further fall in value. Because of still existing capital controls, buying foreign assets in size is not yet possible on the Chinese domestic bond market.

However, this is only an advantage for the time being. At the point of maturity, foreign currency will have to flow from the IBRD to the Chinese bond holders, unless they choose repayment in yuan, in which case the whole exercise would be rather pointless.

So given this lackluster value proposition, why are China, the IMF, and the U.S. controlled World Bank going out of their way to push the SDR into private markets?

Prominent market observers like James Rickards and Willem Middelkoop have long argued that the SDR will be the next world reserve currency. In fact, the current governor of the PBOC Zhou Xiaochuan has advocated for the SDR to become the next global reserve currency for a long time now.

“Special consideration should be given to giving the SDR a greater role. The SDR has the features and potential to act as a super-sovereign reserve currency,” wrote Zhou in 2009. He also wanted the yuan to be included in the SDR, which is going to happen on Oct. 1. Take heed of his predictions.

It’s a geeky name but it’s a kind of world money printed by the IMF. They’ll flood the world with trillions of SDRs.

— James Rickards

“The Chinese … have made it very clear that the Special Drawing Rights of the IMF is the preferred future international world reserve currency,” writes Willem Middelkoop in a note to clients.

“What you are going to see is world money. You are going to see the IMF print Special Drawing Rights (SDR). It’s a geeky name but it’s a kind of world money printed by the IMF. They’ll flood the world with trillions of SDRs,” James Rickards told Epoch Times earlier this year.

Now that the first issuance is well underway, it is easy to lever up the balance sheets of international development organizations and keep issuing—or printing—SDR obligations even in the trillions until even private market actors support and accept them. Once the SDR is widely accepted as payment, the IMF could just redeem all outstanding local currencies for SDR and the world would not only have a new reserve currency, but just one global currency.

“You create new liquidity. That’s the kind of reform that could change the international system immediately,” says Worth Wray.

Willem Middelkoop says this could be done through an IMF substitution fund, an idea already discussed in the 1970s. “This fund could facilitate a direct exchange of dollars for SDRs. The liquidity issue would be resolved with one stroke of the pen, as an SDR would be created for every dollar that was exchanged,” he writes in his note.

Sounds crazy? It is, but the official plan is right here, for everyone to see.

Now in August of 2016, we are very close to the first SDR issuance of the private sector since the 1980s.

Opinion pieces in the media and speculation by informed sources prepared us for the launch of an instrument most people don’t know about earlier in 2016. Then the International Monetary Fund (IMF) itself published a paper discussing the use of private sector SDRs in July and a Chinese central bank official confirmed an international development organization would soon issue SDR bonds in China, according to Chinese media Caixin.

The so-called SDR are an IMF construct of actual currencies, right now the euro, yen, dollar, and pound. It made news last year when the Chinese renminbi was also admitted, although it won’t formally be part of the basket until October 1st of this year.

How much? Nikkei Asian Review reports the volume will be between $300 and $800 million and some Japanese banks are interested in taking up a stake. According to Nikkei some other Chinese banks are also planning to issue SDR bonds. One of them could be the Industrial and Commercial Bank of China (ICBC) according to Chinese website Yicai.com.

The IMF experimented with these M-SDRs in the 1970s and 1980s when banks had SDR 5-7 billion in deposits and companies had issued SDR 563 million in bonds. A paltry amount, but the concept worked in practice.

The G20 finance ministers confirmed they will push this issue, despite private sector reluctance to use these instruments. In their communiqué released after their meeting in China on July 24:

“We support examination of the broader use of the SDR, such as broader publication of accounts and statistics in the SDR and the potential issuance of SDR-denominated bonds, as a way to enhance resilience [of the financial system].”

They are following the advice of governor of the People’s Bank of China (PBOC), Zhou Xiaochuan, although a bit late. Already in 2009 he called for nothing less than a new world reserve currency.

“Special consideration should be given to giving the SDR a greater role. The SDR has the features and potential to act as a super-sovereign reserve currency,” wrote Zhou.

For most people, SDR sounds like an odd disease. And yet, it could be the word’s next reserve currency, at least if China and the International Monetary Fund (IMF) get their way.

The so-called Special Drawing Rights (SDR) are an IMF construct of actual currencies, right now the euro, yen, dollar, and pound. It made news last year when the Chinese renminbi was also admitted, although it won’t formally be part of the basket until October 1st of this year.

IMF members have it and can trade it with each other for actual currencies, which indebted nations like Greece and the Sudan frequently do. The average Joe or the average company on the street can’t hold the instrument right now, let alone spend it.

But that’s precisely what the global monetary elite wants in the not too distant future, and it will use China as a Guinea pig. Before the meeting of G20 central bankers and finance ministers in Chengdu, China, from July 22-23 some academics started pushing the idea of an extended use of the SDR (currently worth $1.39)

“Establishing the SDR as the leading global reserve currency would have far-reaching benefits” Jose Antonio Ocampo, a professor at Columbia University, wrote in a post on Project Syndicate on July 8.

“Beyond the push to use SDRs more actively in IMF programs, governments could issue SDR-denominated bonds. Moreover, private banks could increase their use of this monetary unit, just as some European banks used the so-called European Currency Unit, helping to pave the way for the euro,” he continues.

IMF Is at It as Well

On cue, the IMF itself published a paper on “whether a broader role for the SDR could contribute to [the international monetary system’s] smooth functioning.”

It echoes Ocampo’s idea of private corporations issuing bonds in SDR and banks making loans in SDR, or a special version of it called M-SDR, presumably standing for “market” based instruments like bonds.

The IMF experimented with these M-SDRs in the 1970s and 1980s when banks had SDR 5-7 billion in deposits and companies had issued SDR 563 million in bonds. A paltry amount, but the concept worked in practice.

“M-SDRs emerged in the 1970s and early 1980s before the market faded, but there has been renewed interest recently,” writes the IMF, although it is unclear whether there really exists interest outside the IMFs imagination and some government-controlled entities, like supra-national development organizations.

History of SDR use. (IMF)

To immediately counter this concern, after the G20 meeting on July 25, the deputy director of the People’s Bank of China’s (PBOC) International Office Zhou Juan said an international development organization like the Asian Infrastructure and Investment Bank (AIIB) could issue SDR bonds in China as late as August, according to Chinese newspaper Caixin.

Zhu echoed both Ocampo and the IMF and said that “SDR-denominated bonds should be appealing to official investors at their preliminary stage because they can provide diversified investment products and reduce exchange rate and interest rate risks.”

China has openly called for the SDR to replace the U.S. Dollar as the world’s reserve currency. “China has been pushing for the SDR to become more widely used for some time, as a way to challenge the dominance of the dollar without pushing the renminbi as a direct competitor,” Julian Evans-Pritchard, a China economist at Capital Economics in Singapore, told Reuters.

The IMF did an analysis and concluded financial instruments denominated in SDR would lower volatility and risk compared to holding assets in individual currencies and save costs, just as Zhu said as well. “M-SDRs could, therefore, be attractive to investors and issuers by offering a prepackaged diversification option,” the fund writes.

A Solution for China’s Capital Outflows?

China insider David Marsh, the founder of finance think tank OMFIF (Official Monetary and Financial Institutions Forum) wrote on Marketwatch in late April about another benefit of launching the M-SDR in China, although he did talk about a wider range of applications rather than the issuance by the development institution.

Beijing’s SDR capital market initiative will allow domestic Chinese investors to subscribe to domestic bond issues with a significant foreign currency component, a means of helping dampen capital outflows that have gained prominence in the last 18 months as a result of progressive capital liberalization.

In other words: If Chinese investors can buy bonds or other debt instruments in SDR in China, they could circumvent the capital controls and hold a diversified portfolio of euros, dollars, yen, and pounds with a small amount of renminbi mixed in. And they don’t have to go out of their way smuggling gold across the border to Hong Kong or buying up Italian soccer clubs.

China lost $676 billion in capital in 2015 alone and foreign currency reserves are nearing the critical level of $2.7 trillion (now $3.2 trillion), the minimum the IMF thinks the country needs to run the economy.

So it’s safe to say the IMF had the same issue in mind when it wrote its paper, whose authors we don’t know. In mid-July it stated:

In China, there may be untapped demand among domestic investors for exposure to reservecurrencies as capital controls are gradually lifted. From this perspective, M-SDRs issued in the onshore market could potentially reduce demand for foreign currency and reduce capital outflows by allowing domestic market participants to diversify their foreign exchange risk.

Of course, China, the IMF, and global academics will find a host of problems implementing their plan, including no market clearing mechanism and liquidity issues or simply a lack of demand for a superfluous product that nobody knows or understands.

Superfluous because institutions from central banks to sovereign wealth funds already run their own diversified currency portfolios and don’t need the IMF to tell them which weight is appropriate for their own needs.

There is no demand for the product because it has been around for more than 40 years and it hasn’t been adopted by private players. The only people who are calling for it are government officials and academics and the only vehicle for early adoptions are Chinese state banks or state-controlled international institutions that can’t make a decision on their own.

But practical problems like these have never deterred the IMF or China.

It was in the late 1990s when Willem Middelkoop finally figured it out. He came home from work one day and told his girlfriend: “I understand the financial system.”

This may seem ironic because Willem is not a banker, financier, or an economist. Or maybe not, because most mainstream economists and bankers have a horrible track record at predicting market movements or major shifts in the financial system.

Middelkoop was a photojournalist when he became curious about why he could buy eight properties in Amsterdam with no money down and rent them out straight away for an almost risk-free profit. So he began to ask questions.

It is my belief that, well before 2020, the global financial system will need to be rebooted to a new paradigm in which gold will play a larger role.

— Willem Middelkoop

He found the answers, which helped him understand the financial system—it also led to over 5,000 appearances on Dutch TV and the successful launch of a gold trading company and investment fund.

What Middelkoop learned is presented in “The Big Reset,” originally published in 2013 and updated in 2016 by Amsterdam University Press. Over 100 questions and answers grouped into six chapters, take the reader from the origin of money through the nitty gritty of the banking system, to the history of the U.S. dollar as the world reserve currency, and on to debt, gold, and finally the big monetary reset of our times—the financial crisis of 2008, which Middelkoop predicted back in 2007 on Dutch TV.

Middelkoop is now making his next big prediction.

“It is my belief that, well before 2020, the global financial system will need to be rebooted to a new paradigm in which gold will play a larger role,” he writes.

But first, let’s travel back in time with Middelkoop, who wanted to understand a credit system out of control. If you want to understand banking and credit, you first have to understand the history of money and gold.

(Courtesy of Willem Middelkoop)

A Corrupt System

The lack of training in formal economics works in Middelkoop’s favor here, as he is not clouded by any initial bias. He just wanted to learn the truth about finance and is now sharing his—sometimes critical and out of the mainstream—insights with readers.

This is quite smart, because it is not the bankers themselves but their shareholders that will have to pay these bills.

— Willem Middelkoop

Do you know why gold became the predominant medium of exchange and why it was later replaced by fiat money? How does a gold standard work and what is fractional reserve banking? What is the history of central banking and why are central bankers “lap dogs for private bankers instead of watch dogs,” as Middelkoop puts it.

Like many other researchers who don’t have the academic blinders of economists, Middelkoop criticizes the Federal Reserve (Fed) for its quantitative easing programs and criticizes commercial banks for their addiction to credit, misallocation of capital, and corruption. An appendix lists all fines paid by U.S. banks from 2000 to 2014. The total is $135 billion.

“This is quite smart, because it is not the bankers themselves but their shareholders that will have to pay these bills,” he writes.

This critique leads to further discussions of the leading role of the United States in the world financial system, and why Middelkoop feels the days of the dollar as a reserve currency are numbered.

He doesn’t leave out the relevant history of the Bretton Woods financial system and the closing of the gold window of 1971. Middelkoop also explains the price manipulation , confiscation, and nefarious trading of physical gold of Western governments, central banks, and commercial banks.

The Big Reset

He also delves into why the Chinese have accumulated so much gold and what the end game of their geopolitical initiatives is:

In my humble opinion, China owns all the keys now and they will do what is in their best interest to reach their long term goals. They will continue to play chess on all boards and to support both Russia (big neighbor and needed for commodities) and the United States (worldwide partner for geopolitical and economic reasons). The Chinese leadership understands they need at least another 10 to 20 years to improve their own financial and military structures before they can be in a position to compete with the United States for worldwide leadership.

In the second half of the book, Middelkoop zeros in on the world’s debt load, which cannot ever be repaid in real terms, which is why he warns us away from creative solutions.

“We could even write off all mortgages and nationalize all real estate, and have a system whereby we pay rent to the state. These kind of scenarios are hard to comprehend, but when the need is highest, solutions can become very creative.” It could be the end of private real estate ownership.

A better one would be the ancient debt jubilee where all debts would just be written off every 15 years or so and the system reset, which may be preferable for the majority.

“A breakdown in trust between the most important economic powers could result in a worst-case scenario of escalating trade-, financial- and even real wars, which could include gold confiscations. … There is a risk that a new crisis will occur before a planned reset could be unrolled and chaos will take over.”

Until this crisis occurs, you still have time to read Middelkoop’s book to understand the financial system and its history, and prepare for the Big Reset.

Watching the dealings of the International Monetary Fund can be rather dull. On Jan. 22nd for example, it issued a press release called “IMF Statement on Suriname.” Not terribly interesting unless you either work for the IMF or live in Suriname.
However, the IMF is an important international institution and every once in a while it slips in a highlight which the general public then doesn’t notice, like on Jan. 27.
The press release with the poetic title “Historic Quota and Governance Reforms Become Effective,” for example is worth all the while.
“The reforms represent a major step toward better reflecting in the institution’s governance structure, the increasing role of dynamic emerging market and developing countries,” it says in the statement.
This means primarily more voting rights for the BRIC countries: China (6.07 percent), Russia (2.6 percent), Brazil (2.2 percent), and India (2,6 percent) are now top 10 members of the fund.
Their combined share is less than the United States’s share of 17.085 percent (giving it veto power), however, another interesting change makes the BRIC’s increased voting rights very useful.
“For the first time, the IMF’s Board will consist entirely of elected Executive Directors, ending the category of appointed Executive Directors,” of the top five members consisting of the United States, Japan, Germany, France, and the United Kingdom.
(IMF)
Given this change in the power structure (in theory the fund could be run by all Chinese, although the U.S. veto makes this unlikely) it is not surprising that it took the fund 5 years to make these changes effective.
The IMF needed the approval of at least 85 percent of the capital base (not possible without U.S. consent) and could only move forward after the U.S. Congress finally agreed to the terms in December of last year.
Together with the inclusion of the Chinese yuan in the IMF’s SDR reserve currency, it is indeed a historic shift toward emerging markets.
Talking about the SDR (Special Drawing Rights), the IMF decided to “increase [its] finance strength” by doubling the amount of SDR in circulation to $659 billion.
The IMF uses the SDR as a unit of account in dealing with its own members, so it can also serve as members’ equity capital.
Unlike a normal company, the IMF doesn’t have to go to the market (its members) to raise the money, it can just print it up like a central bank.
The last time this happened was in 2009 when the world was in disarray and China was calling for the SDR to replace the U.S. dollar as the world’s reserve currency. With the world on the edge of a recession and China on the verge of a full-blown financial crisis, does the IMF know something we don’t? Or is it just taking another step to make China’s 2009 wish come true?

The International Monetary Fund finally made up its mind and included China in its basket of reserve currencies on Nov. 30 What they didn’t tell us, however, was how exactly that basket would look like. Until now.
The determination of the weightings and the calculation of the Special Drawing Rights (SDR) exchange rate is very complicated. Suffice it to say the more weight one currency gets, the more important the IMF thinks it is.
The IMF does not waste space telling us that the euro is the biggest loser in the rebalancing, but sometimes two tables say more than 1000 words.
So China is gaining importance and the euro is losing importance.
First: The new weightings after the inclusion of the renminbi:
The new weightings of the SDR currency basket effective October 1, 2016 (IMF)
Second: The old weightings after the last review in 2010 and without the renminbi:
The old weightings without the renminbi, effective December 30, 2010. (IMF)
So the euro loses 6.47 percentage points, the lion’s share of the renminbi’s 10.92 percent. The dollar only loses 0.17 percentage points. Proportionately, the pound suffers the most, it drops from 11.3 percent to 8.09 percent, a loss of 3.21 percentage points or 28.4 percent. The yen loses 1.07 percentage points.
So in this exercise of simple numbers, there are two clear winner, two clear lowers and one country that just fits right in the middle.
MORE:China Uses IMF to Create a New Global Reserve CurrencyThis Time Is Not Different: China Faces ‘Internal Debt Crisis’—Carmen Reinhart
China is the obvious winner, because it goes from zero to 10.92 percent. Given this change, the United States is also a winner, because it only loses a paltry amount. The euro area is the biggest loser in absolute percentage terms while the United Kingdom loses the most proportionately speaking. Japan can live with the small reduction in the weight of the yen.
The bigger story, aside from the numbers, is how China wants to use the SDR to replace the dollar as international reserve currency. Until then, there are few benefits and more disadvantages for China—despite the big percentage gain.

China now officially is part of the International Monetary Fund’s basket of reserve currency’s.
Despite the fanfare, most commentators—including this publication—don’t think it’s a big deal.
Unless, of course, the IMF dramatically increases the use of the basket of Special Drawing Rights (SDRs), which will include the Chinese yuan as of October 1, 2016, alongside the dollar, euro, pound, and yen.
READ HOW THE SDR WORKS HERE
Very few officials have talked about how to increase the SDR’s role in the global financial system. But one of them is the rather important governor of the People’s Bank of China (PBOC), Zhou Xiaochuan. He is calling for nothing less than a new world reserve currency:
“Special consideration should be given to giving the SDR a greater role. The SDR has the features and potential to act as a super-sovereign reserve currency.”
In case you missed this statement, don’t worry. It’s from an essay in 2009 but outlines a clear path to achieve the goal of replacing the dollar as the world reserve currency. With China’s inclusion into the basket, Xiaochuan already achieved his first objective.
He wrote in 2009: “The basket of currencies forming the basis for SDR valuation should be expanded to include currencies of all major economies,” including China, he probably meant to say.
In his essay, Xiaochuan went into great detail explaining how the SDR could become a reserve currency, and basically the backbone of the whole financial system, including the following steps.

Use the SDR to settle global trade and financial transactions
Promote the use of the SDR in commodity pricing, trade, investment and even corporate bookkeeping
Create financial assets denominated in SDR

Right now the SDR is merely a unit of account used by the IMF and its members. Instead, countries, individuals and countries use individual currencies—mostly the dollar—in financial transactions.
Xiaochuan doesn’t like the idea of having just one currency (the dollar) as a reserve currency. He wants “an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run.”
Not News
People like James Rickards, author of “Currency Wars” and “The Death of Money” have been tracking this development for some time.
MORE:Interview With James Rickards: China Planning to Displace DollarThe Tug of War Behind China’s Bid to Become a Financial Superpower
“If you said to me, does China want to get rid of the dollar as the global reserve currency, the answer is yes. But most people think that they want the yuan. They don’t. It’s the SDR,” he told Epoch Times in an exclusive interview.
“The United States is opposing it, but Christine Lagarde [the IMF managing director], is pushing very hard to increase the Chinese role. It’s a complicated global game,” he added.
Why?
Xiaochuan said the new global SDR reserve currency could prevent financial crises like the Great Recession of 2008 and the IMF should manage it.
“The crisis again calls for creative reform of the existing international monetary system towards an international reserve currency with a stable value, rule-based issuance and manageable supply,” he writes.
Rickards says if everything goes according to plan, the United States can do nothing against the IMF launching the next reserve currency. In fact, he said it has already accepted this path and is managing rather than obstructing it.
“According to its charter, the IMF is to function as the world’s central bank, a fact carefully disguised by nomenclature and by the pose of IMF officials as mere international bureaucrats dispensing dispassionate technical assistance to nations in need,” he writes in “The Death of Money.”
In practice, this would mean creating a capital market for SDRs deep enough for companies and governments to use it. In addition, resources such as oil would need to be priced in SDRs, just like Xiaochuan envisions.
Then the SDR could replace the dollar as international reserve currency. Its price would be determined against a basket of international currencies including the Chinese yuan.
“The BRICS and the Shanghai Cooperation Organization may have separate agendas in military and strategic affairs, but they are like-minded on the subjects of IMF voting rights, and they share an emerging antipathy to the dollar’s dominant role,” he writes.
Of course, the real reason is for China to wrestle more power away from the United States. Not even Xiaochuan can determine whether an IMF reserve currency is more or less stable than the dollar. It’s a nice idea, but hasn’t been put into practice.
Voting Rights
The only thing China doesn’t yet have is significant voting rights at the IMF. Right now it only has 3.8 percent of the total votes, not enough to make a difference, at least officially. However, this may change soon as well.
“I think quotas are very dated. If you look at the share of quotas and you compare the share of quotas to the share of world GDP, you see that the quotas are reflecting GDP shares from an earlier era. Not just China, but emerging markets in general expanded their global presence,” says Harvard professor Carmen Reinhart.
The United States has 16.74 percent of the votes at the IMF. Because it holds more than 15 percent of, it can block any decision, giving it effective veto power. And it won’t give up that power anytime soon.
“That’s going to be a hard one. My inclination would be to say that’s still a ways away but I do think that increased voting shares for emerging markets is part of catching up with reality,” says Reinhart.
MORE:IMF Can Control China Through SDR BasketChina Should Get More IMF Voting Rights, Says Harvard Professor

On Dec 1, 2015, Chinese central bank officials didn’t quite want to state that they achieved the first step toward their ultimate goal.
But they did at least hint at it: “China will … contribute to promoting world economic growth, safeguarding financial stability and improving global economic governance.” With the new IMF new reserve currency.

China is in. The International Monetary Fund’s (IMF) executive board confirmed it will include the Chinese yuan in its reserve currency basket on Nov. 30.
“The Executive Board’s decision to include the renminbi in the Special Drawing Rights (SDR) basket is an important milestone in the integration of the Chinese economy into the global financial system,” IMF managing director Christine Lagarde stated.
The decision by the executive board was a mere formality, after IMF staffers already said they supported the inclusion in a Nov. 13 report.
The SDR basket of currencies is the reserve currency of the International Monetary Fund. Every IMF member gets an allotted share or can buy new rights, but the rights themselves do not have real monetary backing.
They can be exchanged against one or all of the currencies in the basket at the exchange rate the IMF determines. So far, only the U.S. dollar, the euro, the pound sterling, and the Japanese yen are part of the basket.
The Chinese yuan will be included as of October 1, 2016. This is an exception to the policy to add a new currency on January 1st of the year after the decision. The IMF reviews the composition of the SDR basket every five years.
“It is also a recognition of the progress that the Chinese authorities have made in the past years in reforming China’s monetary and financial systems,” states Lagarde.
In order to get in, China undertook some reforms in 2015 to make its currency more widely usable, one of the conditions to be part of the basket.
(LeapRate.com)
China allowed greater access to its domestic bond market and liberalized the trading range for its currency, albeit not completely.
However, many insiders think this was a political decision, as the renminbi trails both the Canadian and Australian dollar in the use as central bank reserves for example. Neither of these two currencies are part of the SDR.
Several western diplomats in Beijing told the Financial Times the Chinese government lobbied other countries to support the inclusion irrespective of the normal criteria.
Also, the reforms haven’t been tested enough. “If I was the IMF, I would like to see a lengthy period of time where you can see these reforms in practice,” says “Red Capitalism” author Fraser Howie. “You don’t simply have a free trading currency just because you say so. How is China going to respond in times of crisis?”
“On paper, entry into the SDR signifies that the IMF considers the renminbi to be ‘freely usable’. In reality, China maintains capital controls and the central bank has effectively reinstituted a soft peg to the U.S. dollar since the depreciation in August,” writes Chang Liu, China economist at Capital Economics.
“It is very clear that [IMF staff and management] were willing not to break the rules but to bend them,” Eswar Prasad, a former head of the IMF’s China team told the FT. “Given how much the IMF needs China they did not have much choice.”

China has built up leverage over U.S.-led institutions like the IMF for some time.
“I think they want to join the big boys club, meaning the IMF and World Bank. I think the reason why they are establishing new institutions like the Asian Infrastructure and Investment Bank (AIIB) is to put some pressure on the institutions controlled by the United States,” said Ronald Stöferle, managing director at European Asset Manager Incrementum.
Actual market impact, however, will be small.
“This may be of symbolic significance to some but we think it will make hardly any difference to currency demand,” writes Liu.
MORE:IMF Can Control China Through SDR Basket
Because the SDR is merely a unit of account and no cash changes hands until IMF members start exchanging their SDRs for renminbi, there won’t be more investment or trading in the Chinese currency. Historically, IMF members almost never use their SDR allocations.
China also won’t get more voting rights within the IMF’s decision making structure. A change in the quota shares, as they are called, is different from the review of the SDR basket.
There is another more tangible benefit, however.
“China is the only one who hasn’t engaged in a global competitive devaluation. If they yuan wasn’t accepted in the SDR they would go for a one-off large devaluation. This would be a real-economy crisis with the impact on real asset markets,” said Diana Choyleva, chief economist at Lombard Street Research.

The cat is out of the bag. China will join the club of nations whose currencies make up the international reserve basket.
The basket is called Special Drawing Rights (SDR) and the International Monetary Fund reviews its contents every five years, including 2015.
Tipped for an inclusion this year, China’s yuan has finally gotten the nod.
“The renminbi meets the requirements to be a ‘freely usable’ currency and, accordingly, the staff proposes that the executive board … include it in the SDR basket as a fifth currency,” IMF Managing Director Christine Lagarde stated on Nov. 13.
MORE:Experts on IMF Accepting China Into Reserve Currency Basket [PODCAST]
The final decision by the IMF executive board on Nov. 30 will be a mere formality.
And yet, nobody is getting excited about the move previously lauded as landmark progress.
“The SDR has not relevance to everyday markets,” says Fraser Howie, author of “Red Capitalism.”
The problem with the SDR is that is actually does not contain anything. It is merely the valuation of a basket of currencies with different weightings (dollar, euro, sterling, yen, renminbi) and only exists as a unit of account, used by the IMF.
If a an IMF member country needs one of those or all currencies he can sell his SDRs and get the cash. But before that, it’s all smoke and mirrors.
“In normal circumstances there is no boost in demand for a currency simply because it is in the SDR basket,” writes Mark Williams of Capital Economics.
Prestige
So what are the benefits for China. It’s mostly a matter of prestige.
“One answer is simply that it could. There is no downside, there was little resistance since it is an issue that few in the international community care about, and there is a modicum of prestige in being asked to join a small club, even if few were aware of its existence before,” writes Williams.
The global economic picture may also have influenced the IMF decision, according to Diana Choyleva, chief economist at Lombard Street Research.
“If the yuan is included it is still likely we will see yuan depreciation, but it will be more gradual with heavy intervention from the authorities to make it more gradual,” she says.
China would devalue heavily and swiftly if not included she thinks, shocking the world economy.
Despite the relative insignificance of the event, Fraser Howie believes the IMF should have tracked China for longer before giving it the nod.
“You don’t simply have a free trading currency just because you say so. I as the IMF would like to see a lengthy period of time where you can see these reforms in practice. How is China going to respond in times of crisis,” he asks, referring to the gross mismanagement of the stock market crash this summer.
China severely hindered market forces rather than letting them play out and Howie thinks they could do the same once the currency becomes freely tradable. China has indicated it would like to have complete convertability by 2020.
“After the stock market bubble burst they just continue to clamp down on markets, pull away rights to trade, create an environment where people are afraid to trade even though they have done nothing wrong,” says Howie.
In fact, the IMF has reserved itself a little wiggle room. Instead of accepting the currency as of Jan. 1, 2016, as it is customary, it will wait until September of 2016, despite a positive decision this November.

The International Monetary Fund (IMF) will most likely accept China into its basket of reserve currencies at the end of this month.
Epoch Times business editor Valentin Schmid spoke to two of the foremost China finance experts to discuss the topic and others.
“It’s a foregone conclusion,” says Fraser Howie, author of “Red Capitalism.”
“The omens are good,” says Diana Choyleva, chief economist at Lombard Street.
In this podcast they also talk about:

China’s slowing GDP growth
China as a debt story
Capital outflows
The direction of the currency
The stock market disaster

NB: The interview was recorded before this statement issued by the IMF.

NEW YORK—The International Monetary Fund will take a decision in November that may be the beginning of the end of the China as we know it.
The IMF will most likely vote to include China’s currency in the basket which makes up the fund’s own reserve currency, the Special Drawing Rights (SDR).
For many, this decision is just a reflection of China’s economic rise and a means to control it within the framework of international finance.
For others it could mean the end of China as we know it.
“If China fully integrates its financial system, the leadership framework and the whole power structure will be radically changed,” Fraser Howie, the author of “Red Capitalism” said at a panel discussion hosted by Lombard Street Research in New York on Nov. 4.
Howie thinks market control over interest rates—centrally controlled—and the exchange rate—pegged to the dollar—are incompatible with the current power structure of the Communist Party, which has enriched party elites at the expense of the people.
The CCP only has a small margin of error, if it wants to fully liberalize its exchange rate by 2020. “The window to clean things up is very tight. It’s a very fine balancing act they have,” he says.
Diana Choyleva, the chief economist of Lombard Street Research, doesn’t think change has to be as dramatic, but also warns of a difficult road ahead.
“A successful transition means continued financial distress and continued weak growth as Beijing cleans up the past excesses,” she said at the panel discussion. “China can only be successful with this transformation if the rest of the world is ready to accept the consequences. It’s a tall order.”
Consumer Demand
According to her, China will have to create its own consumer demand as the rest of the world is simply not big enough to absorb all of China’s production as it moves up the value chain. “The easiest way to do that is to free capital flows and allow the market to determine the interest rate and the exchange rate,” she says.
Higher interest rates for savers mean more income for consumers. A market based interest and exchange rate also means more efficient investment and more growth in the future. This process could also correct many of the global imbalances, like the excessive trade deficit the United States runs vis-à-vis China.
Fraser Howie agrees: “If you are going to reform your economy the best place to start is valuing money properly.” So far, China has removed the cap on deposit rates, which it previously held at an artificially low rate to punish savers.

However, Choyleva also thinks a favorable outcome if China’s liberalization is far from certain.
“They could just simply botch the job. We have all seen what happened with the equity market over the summer,” she says.
And if slow growth—Lombard says GDP grew only 1.5 percent in the third quarter—spills over to the labor market, Beijing might not stay the course of reform.
“With the potential to bring social discontent, this will be the real test for Beijing,” she says. According to her sources on the ground, the labor market has already started to weaken in the third quarter of 2015.
Either way, the panelists agreed it would be better to include China in the SDR system. If not, it may become a full participant in the global currency wars.
“If they yuan is not accepted in the SDR they will go for a one-off large devaluation. This is going to be a real economic crisis,” she says. So far, the Eurozone and Japan have both undertaken large scale quantitative easing, pushing the value of their currencies down.
In a comparatively weak response, China has only devalued the yuan by 3 percent in August this year.